We previously reported (seehere and here) on the Ninth Circuit’s consideration of an appeal involving the mortgage interest deduction – specifically, whether the statutory limits on that deduction apply on a per-taxpayer or per-residence basis. The unmarried taxpayers here (Charles Sophy and Bruce Voss) argued that they were each entitled to take a deduction up to the $1.1 million limit for the residence that they co-owned, and thereby receive double the tax benefit that a similarly situated married couple would receive, but the Tax Court disagreed. The briefing in this case was completed in April 2013, but the Ninth Circuit did not schedule oral argument until almost two years later. The court has finally issued its decision, reversing the Tax Court by a 2-1 vote. (Although we have referred to the case as Sophy based on the Tax Court’s caption, the Ninth Circuit opinion reverses the order of the two taxpayers in its caption, and therefore the case may come to be referred to as Voss in the future.)

The majority opinion (authored by Judge Bybee and joined by 8th Circuit Senior Judge Melloy, sitting by designation) recognized that neither the statute nor the regulations directly address this question and then engaged in a detailed textual analysis of various provisions of Code section 163. The majority found the strongest evidence of the correct answer in the statute’s treatment of married taxpayers who file separately. In order to put them in the same position as married taxpayers who file jointly, the statute provides in a parenthetical that married taxpayers filing separately are each entitled to a $550,000 deduction. Because that approach reflects a per-taxpayer rather than per-residence treatment, the majority concluded that the same per-taxpayer approach should be applied to unmarried taxpayers, even though it arguably gives them a windfall double deduction.

The majority rejected the Tax Court’s argument that other provisions of Code section 163 reveal a “focus” on the residence, and it also rejected the Tax Court’s explanation that the approach to married-filing-separately taxpayers was meant to address only the proper allocation of a deduction that is already limited to $1.1 million per residence. Finally, the majority acknowledged that its holding results in a “marriage penalty,” but surmised that “Congress may very well have good reasons for allowing that result” and added that, even if Congress didn’t, the court was bound by the text of a statute that singles out married taxpayers (who file separately) for specific treatment that is not explicitly provided for unmarried co-owners.

Judge Ikuta dissented, arguing primarily that the court should defer to the IRS’s administrative interpretation of the statute set forth in a 2009 Chief Counsel Advice memorandum. She maintained that this informal guidance is entitled to “Skidmore deference,” which the Supreme Court has described as a measure of deference equivalent to the interpretation’s “power to persuade.” The majority found that this level of deference was negligible because the CCA contained only a fairly cursory analysis of the statute, which carried little power to persuade. Judge Ikuta reasoned, however, that the CCA is “more persuasive” than the taxpayer’s interpretation, “which would result in a windfall to unmarried taxpayers.” As to the majority opinion, Judge Ikuta characterized as “the thinnest of reeds” its reliance on the treatment of married taxpayers filing separately.

The government has until November 3 to seek certiorari, but there is no reason to expect that the government would seriously consider seeking Supreme Court review in this case.

Last spring, the Tax Court held in Sophy v. Commissioner,that the limitations on indebtedness for the mortgage interest deduction are applied on a per residence rather than per taxpayer basis. The taxpayers appealed to the Ninth Circuit (Nos. 12-73257 and 12-73261), and filed their opening brief on January 30. The government’s response is due in March.

Under I.R.C. § 163(h)(3), taxpayers are allowed to deduct “qualified residence interest,” which includes interest paid or accrued on acquisition indebtedness with respect to any qualified residence of the taxpayer, or home equity indebtedness with respect to any qualified residence of the taxpayer. For purposes of the deduction, acquisition indebtedness is capped at $1 million and home equity indebtedness is capped at $100,000, for a total indebtedness limit of $1.1 million on up to two residences. The taxpayers, an unmarried couple registered as domestic partners with the State of California, had approximately $2.7 million of indebtedness associated with their primary residence in Beverly Hills and secondary residence in Rancho Mirage, California. They argued that, together, they should be able to deduct interest paid on up to $2.2 million of indebtedness, or $1.1 million each. The Tax Court rejected this position. Parsing the language of the statute, the Tax Court noted repeated references to “residence” in the provisions on the indebtedness limitations and concluded that the limitations are “residence focused rather than taxpayer focused.” The Tax Court also found support for treating the $1.1 million limitation as a per residence rather than per taxpayer limitation in the subsection of § 163(h) that provides that married taxpayers who file separate returns are limited to half of the otherwise allowable amount of indebtedness, and in the general rule that married couples filing jointly are subject to the $1.1 million limitation.

On appeal, the taxpayers argue that § 163(h) should be construed consistently with I.R.C. § 121, which limits the exclusion of gain from the sale of a taxpayer’s “principal residence” to $250,000. Under the regulations, the limitation is applied on a per taxpayer, not per residence basis. Section 163(h) defines “principal residence” with reference to § 121. The taxpayers also argue there is no reason to treat non-married couples the same as married couples for purposes of § 163(h) because differential treatment “is consistent with various provisions of the Code where there is a different result for similarly situated taxpayers based on filing status.”

About Miller & Chevalier’s Tax Appellate Blog

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The Tax Appellate Blog is intended to be a resource for information on important tax cases under consideration in the appellate courts. It will feature insightful commentary on the issues and provide a dedicated site for following the progress of these cases.

Authors

Steve Dixon is a Member in the Tax Department at Miller & Chevalier. He specializes in controversy and litigation, representing taxpayers in the Tax Court and Federal courts.

Laura Ferguson is a Member of the Supreme Court and Appellate Litigation Group at Miller & Chevalier and has successfully briefed and argued six cases at the U.S. Courts of Appeals in the past two years. Ms. Ferguson also has extensive experience litigating complex, high-stakes tax cases at the Tax Court and federal district courts.

Alan Horowitz is the former Tax Assistant to the Solicitor General at the Department of Justice, where he briefed and argued numerous tax cases in the Supreme Court. He is currently the head of the Supreme Court and Appellate Litigation Group at Miller & Chevalier.